the Internal Revenue Service. Recent IRS figures show that upward of 19 million companies with revenues of less than $1 million are operating throughout the country. Small companies are bountiful suppliers of funds that banks can lend to larger companies. Profit margins are high due to the wide spreads on these deposits and the relatively low credit risks involved, owing to the fact that small businesses are rarely big borrowers. Of late, many banks have successfully raised their fees for commercial deposit accounts at about twice the rate they have for personal demand deposit accounts, further bolstering their revenue stream from small businesses. Our research shows that these commercial fees climbed 26% between 1989 and 1993 versus a 12% to 15% rise for personal accounts. Larger firms, of course, are net fund users and targets for loans. But even among firms that borrow, plenty still maintain substantial deposit balances. As the economy grows, lending is again on the increase, with more of these firms borrowing to expand depleted inventories and fund growth. The cash balances among small businesses will also expand as the economic cycle advances, leading to a sizable growth in deposits. All of this is good news for branch managers. Small businesses tend to act much like individual retail customers, looking to banks mainly for checking accounts. Demand for other services is often quite limited. According to a study of businesses with fewer than 500 employees by the Federal Reserve Board, barely 23% establish lines of credit. Only a quarter take out auto loans, and a mere 12% use equipment loans. As always, managing costs is a key to enhancing profitability. Take channel costs. Here plenty of banks err. When moving accounts from the branches into the commercial division, managers often set arbitrary cutoffs - for example, only customers with X million dollars or less in sales size stay in the branches. Yet bigness isn't necessarily an accurate guide to borrowing needs. Many customers with millions in revenues rarely borrow, if ever, and need nothing more than infrequent consultations with a loan officer. Keeping such accounts in the branch could mean substantially larger profits. Consider the payoff that might come from a less arbitrary approach. Typically, the charges for handling a small business at the branch level run between $400 and $600 annually. Moving that account from the branch into the commercial division can result in a 25-fold increase in costs. Placing an account higher up the organizational chain and putting it into the upper middle market division will push costs up a further fourfold. Moral: Before moving the account out of the branches get a firm handle on the extra revenues and fees you will get to cover the additional costs. Conversely, banks can suffer if they let branch managers hold on to accounts that would be better served with the more sophisticated offerings available higher up the organization. Unfortunately, here's where turf wars often get in the way, with branch managers in a seemingly endless and fruitless battle with the commercial division. Banks can achieve a better approach to selecting channels if they first segment their small-business customers, then develop a detailed profile. From this will emerge the key factors that determine profitability in each segment. Armed with that information and the management processes to act upon it, selecting the correct channel becomes a snap. What is also needed is a system of rewards and incentives that will ensure that accounts get handed over - either upward or downward - in a manner that bolsters profits overall. Branch managers need to be measured and rewarded to encourage them to build up their small-business accounts, then pass them along at the appropriate moment to the commercial division. This is not an area that will manage itself. As a small business grows, it becomes one of the more lucrative accounts at the branch. No branch manager will let it go willingly without an incentive, and some service functions may stay in the branch. At some banks, the commercial divisions will "buy" a customer from the branch system, giving the branch manager a share of the value of the future profit stream. Figuring out a form of transfer pricing is not necessarily easy, but it is essential. If banks aren't careful, their customer will vanish in the midst of an internecine tug of war, cherry-picked by a competitor promising better attention or lower service charges. And, of course, customers switch bankers for any number of reasons: indifferent service, excessive fees, or simply because they have outgrown what their current bank thinks they need. Mr. Mara is a vice president and Mr. Gregor is a senior vice president at Gemini Consulting, Morristown, N.J.

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